A 10-Year Review of Cap Rates vs Borrowing Costs

This is a very thorough report of the relationship over the past 10-years of commercial real estate capitalization rates and borrowing costs. Despite rising rates in the past 18 to 24 months, CRE cap rates have been stable or even declining.

Why is this? Partly due to the fact that there are still limited opportunities for investors to find conservative, high-yielding investments in the market, and partly due to the fact that future interest rate increases are expected to be moderate to non-existent from this point.

I also believe that the institutionalization of real estate as an alternative investment class has broadened its appeal and that, over time, the cap rates of diversified real estate portfolios will continue to narrow against other assets, such as fixed income portfolios.

From the report:

Historical data indicates higher interest rates have not necessarily weakened real estate returns. Real estate performance has remained resilient despite rising Federal Reserve rates. Prime Rates remained quite low during the initial Fed hike at the end of 2015. At the end of 2018, the Federal Reserve had anticipated that two additional hikes will occur in 2019, however there have been talks for a slow down to keep rates steady.

There is a perception that rising interest rates will drop down property values and real estate return due to higher debt. When taking a closer look at real estate performance, there are a number of factors that may provide protection to overall performance in a rising interest rate environment. Cap rates are influenced by real estate fundamentals (operations), capital flows and investor risk appetite in their respective economic and property market environments.

Fed rate and inflation all have some influence over long-term fixed rates, which generally are yield sensitive on the 10-Year Treasury note. Any movement in the long end of the yield curve can affect both buyer perceptions of the relative rates of return on offer as well as the costs of financing. There has been a general increase in the 10-year treasury rate since 2016 and cap rates have been lowering yet steady. Over the course of the last 10 years, the cap rate spreads to the 10-year treas- ury yield is narrowing to the same range as 2003-2006. The current spread is a healthy cushion against rising interest rates. The 10-year rate is depressed but is still ahead of inflation and the con- sumer price index (CPI).

Data shows us that U.S. cap rates remained stable and flat, with deal volume growing slightly de- spite the eight Federal Reserve interest rate increases since 2015 across all property types. This stability correlates with the stability of the 10 Year Treasury note. CRE and 10-Year Note spreads re- main wide, and margins are less at year end 2018. While the anticipation of prime rates increasing steadily, we will see narrowing of these cap rate spreads.

Full Report Here: https://www.qreadvisors.com/wp-content/uploads/2019/02/Feb-2019-Cap-Rate-vs-Borrowing-Cost.pdf

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